Earnings Trounce Expectations…and that might be an Understatement

Call it the impact of a surprisingly strong economy. Or call it the result of a pessimistic bar set too low in the first place. But don’t call the recent strength in corporate earnings expected. In aggregate, first quarter earnings growth surpassed analyst expectations at a rate rarely seen in the past 15 years, and it may even have sparked a sentiment shift on Wall Street.*

A Wall Street Journal article last Wednesday did a great job of putting first quarter corporate earnings growth into perspective, and highlighted some of the reasons earnings are on the rise. But one item that has been largely overlooked this earnings season is just how far, and how often, the results have surpassed expectations.

At 361 Capital, several of our strategies track analyst earnings estimates to predict how analyst expectations of a stock will change in the future. (You can read more about the strategies and how Wall Street analyst estimates influence stock prices in this paper.) As a byproduct of our process, we keep many statistics on analyst earnings estimates, and found some interesting results when comparing them to companies’ actual first quarter results.

For the three-month period ending May 31, 54% of stocks beat consensus estimates by more than one standard deviation – a level of magnitude that only includes meaningful earnings beats and eliminates the close calls in which a company’s earnings per share topped expectations by a mere penny or two. This represents the highest level of earnings beats recorded in 15 years.

Meanwhile, only 12% of companies announced earnings one standard deviation below consensus expectations, the lowest level recorded since 2010. Perhaps most impressive, the spread between the percentage of stocks substantially beating consensus estimates and the percentage of stocks substantially missing was the highest three-month value observed in 15 years.

Is a mood change in order?

While strong corporate earnings may have caught Wall Street analysts flat-footed in recent weeks, it appears their sentiment is now improving. In April, 57% of all revisions to analysts’ earnings estimates of specific companies were upward revisions which is the most optimistic observation measured since mid-2012. And in May, 55% of all analysts’ earnings revisions were positive—the second most optimistic over that same time period.

Estimate upgrades have been notably strong in the Industrials, Utilities and Health Care sectors, while analysts have continued to reduce forecasts for stocks in the Telecom, Real Estate and Materials sectors.

A single quarter doesn’t make a trend, but it will be interesting to watch whether expectations get closer to actual results next quarter, and whether analyst revisions continue to trend upward.